Irish Economy 2008: AIB Bank today says in an update on Ireland's economy:
Where Does it Stand and Where is it Going?, that it is facing significant challenges in 2008/2009 including a marked slowdown in global growth, a sharply higher exchange rate, rising interest rates, tightening of credit conditions, a steep decline in housing activity, rising unemployment, weakening confidence and fiscal tightening. The bank says that tough budgets are required in 2009 and 2010 to maintain the public finances in a healthy condition.
The Irish economy had already lost considerable momentum in the second half of 2007, with GDP growth slowing to 3.7% year-on-year, down from close to 7% yoy in H1. The data published for the opening five months of 2008 point to a further weakening of domestic activity. Housing output continues to contract while growth in consumer spending has slowed sharply. Tax receipts have been very weak and the jobless total has spiked upwards.
A sharp decline in new housing output will greatly depress GDP growth in 2008 and 2009. Housing completions are forecast to fall to 47,500 this year and 33,000 in 2009, down from 78,000 last year. With new housing investment and associated transfer costs accounting for 11% of GDP, the decline in housing will knock some 4% off GDP growth in 2008 and 1.8% off in 2009.
Domestic spending is forecast to contract by 1.7% this year and rise by a meagre 0.1% in 2009 as a result of the sharp fall in housing output, along with much slower growth in consumer spending, government expenditure and non-residential investment. As in 2007, though, net trade should again make a significant contribution to GDP growth in 2008-2009. Given the weakness of domestic spending, import growth should slow. Export growth should slow also, given the difficult external environment.
However, AIB says that there appears to be a strong, structural uptrend in service exports, which should help underpin total exports. Overall, net trade is expected to add around 2.8% to GDP growth in 2008 and 2.4% in 2009, having contributed 2.25% in 2007. Nonetheless, GDP growth is forecast to slow sharply to 1.3% this year and 2.5% in 2009 from 5.3% in 2007.
The sharp slowdown in economic growth will hit the labour market hard. The bank expects employment growth of just 30,000 in 2008, down from 67,000 last year, with no job growth envisaged for 2009. A fall off in inward migration and a decline in participation rates will help curtail the rise in unemployment.
However, the jobless rate is expected to pick up to close on 6.5% by 2009.
Medium Term Growth Prospects Remain Favourable
AIB says economic growth is cyclical and it sees the economy returning to a solid growth path once the marked downward adjustment in housing activity is complete and the global economy regains momentum. The fact that GDP growth excluding housing averaged 6.2% in the last three years and Ireland also enjoyed very robust job growth in this period indicates that the economy is more competitive than commonly assumed.
However, recent exchange rate movements do pose considerable challenges for the traded sector and highlight the need for a moderation in wage and price inflation. Service exports, though, have been performing very well and may be less vulnerable to global competitive pressures than goods exports.
They have risen at a double digit rate for the past five years and were up by over 14% last year. They now account for 44% of total exports and have become the new growth engine of the Irish economy.
AIB's forecast is for GDP growth to recover to 4% in 2010. Looking further out, it says that the economy can achieve an average growth rate of 4.5% in the period 2010-2014 led by strong growth in the services sectors, in particular exports of business, financial and I.T. services. Growth should also be boosted by a renewed pick up in house building activity as it recovers from low levels.
Inflationary Pressures Slow to Abate
Inflation is proving sticky and the CPI rate looks set to average 4.6% this year, with the HICP (EU Harmonised Index of Consumer prices Index) rate picking up to 3.5%. Very sharp increases in food and energy prices are driving up inflation world wide, with high mortgage repayments adding to CPI inflation in Ireland as well. The bulk of the price rises in Ireland have come from external sources. Thus, the recent rise in inflation is a global event and not just an Irish phenomenon. With oil prices rising further and mortgage rates going up, AIB does not expect Irish inflation to fall over the balance of the year from its current high levels.
The appreciation of the euro and weakening domestic demand and labour market conditions should see inflationary pressures in Ireland wane next year. Obviously, the trends in food and energy prices will have a major bearing on inflation going forward. These are hard to forecast but provided the upward pressure on food and energy prices eases, CPI and HICP inflation rates could fall back to around 3.5% and 3.0%, respectively, in 2009 and ease further in 2010.
Tough Budgets Ahead In 2009 and 2010
Although Ireland's fiscal position remains sound, tough budgets are required in 2009 and 2010 to maintain the public finances in a healthy condition. Tax receipts are likely to undershoot target by around €2.5 billion this year, pointing to a budget deficit of 2.2% of GDP, which compares to a surplus of 3% of GDP in 2006. This deteriorating trend in the budget balance cannot continue, AIB says. Top priority must be given to reining in the runaway growth of current spending on services.
Gross current supply services spending has jumped from €22 billion in 2000 to €53 billion this year, an increase of over 140% in the space of eight years. It now equates to 32% of GDP, up from 24.7% in 2000. Spending growth may well have to be capped at 4% in 2009 and 4.5% in 2010 to maintain the budget deficit at around 2.5% of GDP. Capital spending plans may have to be reviewed in this context but the government should ensure that any cutbacks in this area have a limited impact on the future growth potential of the economy, which is still burdened by a considerable infrastructure deficit.
Commenting on the report, John Beggs, Chief Economist said:
"Downside risks dominate the global economic landscape, which is faced by a marked tightening of credit conditions, unsettled financial markets, rising commodity prices and a weakened US economy. As a very open economy, Ireland is impacted by this difficult global picture. It is also faced with unfavourable exchange rate movements. Meanwhile, on the domestic front, the housing market is undergoing a marked downward correction which is depressing GDP growth.
This backdrop presents a very challenging environment for the Irish economy. The outlook for 2008 is for GDP growth to slow to 1.3% from 5.3% in 2007. Activity is expected to remain sluggish in 2009, with GDP growth forecast at 2.5% for next year. Domestic spending is forecast to contract by 1.7% this year and rise by a meagre 0.1% in 2009, with net external trade the driver of GDP growth for the period.
Thus, it is not surprising that the downturn in the economy has a recessionary feel to it. It is important, though, to keep the downturn in perspective as it comes after a prolonged period of very robust growth stretching back to the early 1990s. The economy will still hold onto virtually all the substantial gains in output, employment and living standards achieved since 1993.
The strong performance of the economy leading up to this downturn, especially in the non-housing sectors, augurs well for a resumption of robust economic growth in the next decade. The fundamentals of the economy also remain sound. Hence, we expect GDP growth to pick up to 4% in 2010 as the downturn in housing bottoms out and global growth improves. Looking further out, we think that the economy can achieve an average growth rate of 4.5% in the period 2010-2014 led by strong growth in the services sectors, in particular business, financial and I.T. services, which have become the new growth engine of the Irish economy.
In the meantime, it is important that public policy is aimed at ensuring the economy will be in a position to take advantage of the next upswing in the global economy via sustaining competitiveness, improving public infrastructure, encouraging innovation and maintaining a relatively low tax environment.”
